FAR EAST FOCUS: Siberia an opportunity too good for Japan to pass up

For energy-ravenous Japan, a tiny inlet in the Russian Far East offers a chance to kill two birds with one stone.

Kozmino port, which is situated close to Russia's borders with China and North Korea, could be key to Japan being able to slake its thirst for oil and diversify its source of supply for other forms of energy.

There is an additional benefit: Kozmino faces the Sea of Japan. For a supertanker laden with 100,000 tons of fuel, it takes only a day and a half to make the crossing.

Kozmino, in the southern part of the Primorsky Territory, is the terminal point of the East Siberia-Pacific Ocean pipeline, which is operated by Transneft, a state-controlled company. It was completed in 2010.

The Primorsky Territory is rapidly becoming an industrial and economic hub because of its proximity to countries in Asia and the Pacific.

Moscow is investing huge sums in projects to create efficient ways to transport oil across the vastness of Siberia. The oil is destined for export and the development of local industry.

Until the early 2000s, shipments were limited to Europe, which is essentially Russia's backyard. Shipments out of Kozmino did not begin until late 2009.

The 4,800-kilometer East Siberia-Pacific Ocean pipeline was designed to transport oil to the coast of the Sea of Japan and only completed this spring. The pipeline is set to become fully operational in November.

Currently, oil is transported in containers on the Siberian railway. To reach the coast entails a journey of three to four days.

Once a direct link is in place, annual shipment volume from Kozmino port is expected to double next year to 30 million tons.

Construction work on the port's facilities is continuing at a furious pace. All this activity is helping to transform the surrounding city of Nakhodka (population: 225,000).

Work to construct a petroleum export and processing base after the pipeline is completed is expected to create 15,000 new jobs.

Local authorities estimate that the region's annual gross domestic product will rise by 52 billion rubles (130 billion yen, or $1.6 billion) once everything is in place.

Russia also has another card to play: exports of natural gas.

Last September marked the opening of a 1,800-km pipeline linking Vladivostok, in the Primorsky Territory, with Sakhalin. This year, construction will begin on a 3,000-km pipeline that will link Vladivostok with the Chayanda gas field in Siberia.

By 2018, Russia expects to have a second liquefied natural gas plant operating at the Vladivostok terminal for export.

There are also plans to construct a gas chemical plant. Natural gas from wells in Chayanda, some 4,200 km east of Moscow, contains many byproducts, such as helium. If these can be extracted and refined, officials say they have a ready market for industrial use.

Aleksey Kontorovich, chairman of a scientific council on geology and exploration of natural resources at the Russian Academy of Science, said: "Russia is said to depend on natural resources because all it has done until now is to export them. It is now a state objective to place added value on these resources so that local industry can benefit."

Japan is ratcheting up its involvement in these state projects.

Oil shipments to Japan from Kozmino port fell sharply after the Great East Japan Earthquake in March 2011, but recovered to 1.7 million tons in the first four months of this year. The figure represents one-third of total shipments out of Kozmino, making Japan the port's biggest buyer.

Japan's Ministry of Economy, Trade and Industry (METI) has signed an agreement with Gazprom, Russia's government-affiliated gas company, to do a feasibility study on construction of an LNG plant in Vladivostok. The trading company Itochu Corp., and other Japanese conglomerates, are involved.

Several leading trading companies in Japan are also involved in the gas chemical plant plan.

"We don't only hold high expectations for the technology held by Japanese companies. It is also important for us that they have sales channels (for natural resources and products) in the Asia-Pacific region," said a high-ranking official for Gazprom who handles matters relating to East Siberia and the Russian Far East.

Last Oct. 17, Alexey Miller, the Gazprom president, had a frenetic round of meetings with various dignitaries who were visiting the company's headquarters in Moscow.

Among those he met that day were Paolo Scaroni, the CEO for Eni SpA, Italy's largest energy company and a partner in the South Stream project to construct a pipeline to southern Europe. Miller also met with leaders of republics within Russia as well as the deputy prime minister of neighboring Belarus.

But it was separate visits by two Japanese groups that held Miller's attention.

One group was led by Eizo Kobayashi, the chairman of Itochu, which is involved in the feasibility study for an LNG plant in Vladivostok. The other group was led by Masami Iijima, the president of Mitsui & Co., which has invested in the petroleum and natural gas development project Sakhalin II.

The two sides had initially agreed not to exchange gifts so as to keep the meetings on a more businesslike footing.

Nevertheless, Miller presented his Japanese guests with expensive ceramic gifts.

"It could be that Prime Minister Vladimir Putin gave instructions to Gazprom to welcome the officials of the Japanese trading companies in a gracious manner," said one source.

Three days before those meetings, Putin spoke with Prime Minister Yoshihiko Noda by telephone. One of the topics of conversation was the supply of LNG and electricity by Russia to Japan.

Putin, a self-professed Japanophile and judo black belt, has aggressively pushed energy development projects in Siberia and the Russian Far East.

Work on the East Siberia-Pacific Ocean oil pipeline began in April 2006. In September 2007, Putin instructed the government to draw up plans to develop natural gas in East Siberia and the Russian Far East for export mainly to China and South Korea.

However, Russia now appears to be leaning toward exporting LNG primarily to Japan.

If all goes according to plan, the LNG plant in Vladivostok will produce 10 million tons annually from 2018. Itochu and Japan Petroleum Exploration Co. are key partners in the venture.

Big-name Japanese companies are also the front-runners in winning orders for the construction of a gas chemical plant that Russia wants to serve as a catalyst for local development.

The nuclear disaster in Japan last year has forced the Japanese government to fundamentally review its energy policy. For the time being, Japan is coping with a lack of nuclear power by increasing the ratio of electricity generated by thermal power plants that use natural gas as fuel.

Japan, because it is an island nation, depends on tankers to transport LNG to meet its import needs for natural gas.

In 2011, natural gas imports came to 78.53 million tons, a 12-percent increase over the previous year due mainly to increased demand by electric power companies. Imports from Russia rose 18 percent to 7.12 million tons.

It takes tankers between three and four days to reach Japan from Sakhalin.

Shipments from the Middle East take 20 days.

Iran has sparked anxiety in Japan with its threat to close off the Strait of Hormuz, through which tankers must pass. An added problem is that the Strait of Malacca is awash with marauding pirates.

Vladivostok, on the other hand, offers the prospect of shipments arriving within 36 hours.

"The new project will be hugely beneficial (for Japan)," said Nikolay Lovigin, who heads the energy, oil and gas complex and coal industry department of Primorsky Territory.

Concern has been raised in Vladivostok about global exploitation of natural resources.

At a May 17 forum there that attracted corporate executives of companies in Siberia and the Russian Far East, as well as researchers and representatives of government agencies, one participant said, "You should look at global developments far more seriously."

The comment was triggered by a response to a question about the effects of shale gas development.

A scholar responded, "Nobody anticipates any problems for the next 50 years."

Russia in recent years has been pushing to expand its energy ties with the Asia-Pacific region. Circumstances seem to have forced Moscow's hand.

Europe used to be the major market, but the financial crisis there has dashed hopes that energy demand will rise significantly in the near future.

Moreover, the development of technology to extract shale gas from deep underground more cheaply has sent natural gas prices in the United States plummeting to levels half of what they were a year ago.

With the LNG produced in Qatar that had once gone to the United States but is now heading to Europe, price competition has intensified for Russian natural gas.

Relations with China and South Korea in the Russian Far East have also run into problems.

While a pipeline to China from Turkmenistan began operations in late 2009, no agreement has yet been reached on price.

Another plan to construct a pipeline connecting Russia with South Korea through North Korea has also hit a brick wall.

Russia is not the only resource-rich nation looking toward the Japanese market.

Japan has been caught in a Catch-22 situation. It has been forced to purchase more natural gas, and that has pushed up the price.

Prior to the Great East Japan Earthquake of March 11, 2011, Japan paid $10 per 1 million Btu (British thermal unit) of LNG. It now pays $18 per Btu.

That is eight times what the United States paid and about 50 percent higher than prices in Europe.

A number of new LNG development projects are in the offing.

According to the Agency for Natural Resources and Energy in Tokyo, production is set to start in at least 11 locations, centered in the Asia-Pacific region, by 2018. There are also plans to import U.S. shale gas in the form of LNG.

With that outlook, an Itochu executive said, "If we are competing with projects in other nations, we will have to receive assistance from the Russian government and get tax breaks."

Clearly, Japanese companies have high expectations of doing business with Russia.

Energy cooperation with Russia will help Japan move away from its dependence on nuclear energy and secure alternative energy sources.

One trading company source with many years of experience working in Russia said, "It is in the interest of both nations to be as flexible as possible and assess what possibilities exist beyond LNG."

The idea of constructing a gas pipeline connecting Sakhalin directly with Japan has also been mooted.

On May 3, Seiji Maehara, the policy chief for the ruling Democratic Party of Japan, met in Moscow with Alexander Medvedev, a deputy chairman of Gazprom's Management Committee.

Medvedev asked Maehara, "What do you think about a gas pipeline connecting Sakhalin with Japan?"

Medvedev was proposing selling gas rather than LNG to Japan.

Maehara responded, "The LNG project in Vladivostok would have to be the major precondition, but we are also keen to hold discussions on alternative sources of supply."

Other Japanese participants at that meeting sought a clarification as the proposal was at odds with the LNG project that is being promoted by the two nations.

Medvedev said, "It is technologically possible. While priority will be placed on the supply of LNG and the pipeline idea is still something being thought up, we feel consideration should also be given to bringing that idea to realization."

As it happens, a number of interested parties in Japan have called for just such a pipeline in the wake of last year's natural disasters.

One reason for the recent sharp rise in LNG prices to Japan is the fact that shipments must come by sea, and not pipelines used to supply Western nations.

Akira Ishii, a special adviser for the Japan Oil, Gas and Metals National Corp., said building a pipeline would give Japan the opportunity to "negotiate with Russia to keep prices the same as those for Western nations."

In February, Hiroshi Ozaki, president of Osaka Gas Co., attended a deliberative council meeting at the economy ministry looking into construction of a domestic gas pipeline.

"Japan needs to consider whether it can tap into an international pipeline in the future," he said.

The comment attracted the interest of industry insiders because the gas industry until then had been considered cautious about pushing such a proposal.

Just over a decade ago, serious consideration was given to having gas piped directly to Japan.

Itochu and Marubeni Corp., which invested in the Sakhalin I project, spent three years from 1999 on a feasibility study.

At that time, the companies considered construction of a pipeline stretching some 1,000 km that would pass through Cape Soya at the northern tip of Hokkaido and run along the Pacific coastline of Hokkaido and the main island of Honshu before reaching the Tokyo metropolitan area.

Exxon Mobil Corp., which was in charge of Sakhalin I, lobbied Japanese electric power and gas companies to adopt the proposal, but negotiations collapsed in 2006.

A TEPCO executive at that time said, "We couldn't sign a contract because no specific price or supply volume was presented."

An Exxon Mobil source said, "TEPCO and other companies were opposed because they would have had to pay out huge amounts of compensation for those in the fishing industry."

There was speculation that a project of this scale would destroy the regional monopolies enjoyed by utilities as any company would have been able to purchase fuel for electric power generation or gas supply if branches were constructed from the pipeline.

This gave rise to other issues. Gas cannot be stored in large volume and problems would arise if supply was suddenly stopped.

The construction expenses were estimated at a prohibitive hundreds of billions of yen, an amount that could not be found unless major buyers for the gas were in place beforehand.

An executive with a major natural resources company said, "In the end, no progress will be made unless a decision is made about who will provide the money."

(This article was written by Takashi Kida in Kozmino, Masami Ono in Vladivostok and Tetsuo Kogure.)

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